Investors in online lending have a wealth of credit bureau data to assess when developing an investment strategy. Credit bureaus track many types of behavior, including delinquencies. A delinquency is defined as a failure to pay the minimum payment on an obligation by the time it was due. Credit issuers have their own internal protocols that determine when delinquency data is transmitted to the credit bureaus. Some issuers may only report a delinquency if the borrower has missed at least two payments, others report after one missed payment. Because of this, all delinquencies are not the same, and some could be simply associated with sloppy payment behavior, as opposed to financial distress. Prosper’s data includes a summary historical delinquency variable that contains the total number of delinquent accounts over the last seven years.
To understand if this variable is predictive, we will take a look at Prosper loans made in 2012. Below, we show the distribution by credit grade of loans with and without a delinquency. As would be expected, the higher risk credit grades include a higher proportion of loans with previous delinquencies. In total, about 30% of borrowers from 2012 have at least one historical delinquency. This is not a surprise given the term’s broad definition. Also, seven years is a long period of time, one in which a borrower’s financial situation could have drastically changed.
The next question is whether having a delinquency vs. not makes a difference in aggregate. The below chart shows that there is a small difference in default rate (defined as at least one late payment, which is what we track given that 2012 loans still have not fully matured) between the two groups.
The same pattern exists by credit grade, although we see that it becomes less significant and even potentially reverses in the higher-risk grades.
So far, we’ve been looking at accounts with every delinquency lumped together. It is possible that many borrowers have one or two delinquencies, and the variable only becomes predictive of future default if there are more than just a few occurrences.
Here we show the default rate for Prosper 2012 borrowers based on how many delinquencies are on the credit bureau. The far right bar in the chart includes all those accounts with 20 or more delinquencies. The default rate is similar across the board, and does not get worse as the number of delinquencies increases. In fact, borrowers with three delinquencies have one of the highest default rates. This number is quite arbitrary and unlikely to be representative of a pattern that would repeat in the future. This kind of insight is where credit analysis goes from being a science to an art. It is important to scrutinize all inputs to a strategy to ensure the pattern seen is actually a pattern, and makes sense to rely on in the future. In the case of historical delinquencies, it does not appear to be predictive of default in general. This is likely because of the general nature of delinquencies, the length of the seven-year time period being assessed, and the initial credit screen performed by the origination platform itself.